ETF Focus

Swapping Index Partners

Competition among index creators is encouraging ETF sponsors to shop around for better benchmarks—and cheaper licensing deals. What it means for investors. Also, commission-free ETF trading, and a bevy of new funds.

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"Fee war" or not, there's no denying big exchange-traded fund companies compete on cost. The rivalries are extending beyond management fees to include brokerage commissions and, more recently, the cost of index licensing. The last was near the top of the agenda at Index Universe's Inside ETFs conference, the biggest ETF event of the year, held last week in Hollywood, Fla.

Mark Wiedman, head of iShares, the largest ETF sponsor, told conference-goers that the company is reviewing its indexing contracts, a not-so-subtle shot across the industry's bow. The assertion that iShares' $591 billion in assets is nobody's cash cow follows Vanguard Group's shift of more than half a trillion dollars of mutual-fund and ETF assets away from well-known
MSCI
(ticker: MSCI) benchmarks to less widely used FTSE Group and University of Chicago indexes, to keep a lid on costs. So, yes, the fee wars have become indexing wars.

For investors, the new rivalries bring trade-offs that don't come into play when ETFs simply lower their management fees. In this case, fund companies are seizing opportunities that arise from hotter competition in the indexing business. Besides the ascendant FTSE Group, there are players such as
Nasdaq OMX
(NDAQ) with fresh benchmark-building ambitions. Nasdaq's recent moves include launching thousands of new global benchmarks and buying a family of dividend-themed indexes. "We're already an MSCI competitor," Nasdaq OMX Group's John Jacobs told Barron's at the conference.

Fund companies have simply realized there are more indexing options to consider, and they want investors to adapt.

Take Vanguard's shift to FTSE Group and University of Chicago indexes. While the company predicts the move could save hundreds of millions of dollars over time, investors are right to focus on what it means for their investments today. By switching indexers,
Vanguard FTSE Emerging Markets
(VWO), one widely owned ETF, is eliminating a 15% weighting in South Korean stocks. Investors who liked that exposure have to decide whether to live with the change or alter their portfolio. FTSE's indexers consider South Korea a developed market.

"We weren't thrilled with Vanguard's decision to leave MSCI and move to FTSE," Larry Whistler, president of Nottingham Advisors, said at one of the week's discussion panels.

A buy-and-hold alternative getting more attention lately is the four-month-old
iShares Core MSCI Emerging Markets
ETF (IEMG). The fund offers a variant on the original MSCI index, with an 0.18% expense ratio that undercuts Vanguard by a small margin, to boot.

BROKERAGES' COMMISSION-free ETF trading, which may seem a more clear-cut win for investors, also involves trade-offs. The driver is the increasingly intricate set of alliances between fund sponsors and brokerages. Fund companies footing the cost of free trading expect assets to flow in return, especially into ETFs that haven't attracted many investors. Two weeks ago, discount brokerage
Charles Schwab
(SCHW) expanded its commission-free ETFs to more than 100, edging out TD Ameritrade for the biggest lineup. Schwab's includes popular funds such as the
PowerShares S&P Low Volatility Portfolio
(SPLV) and Guggenheim's BulletShares defined-maturity ETFs, as well as sparsely owned funds like
Guggenheim China All-Cap
ETF (YAO) and
PowerShares Dynamic Media
(PBS). There are no offerings from industry-leading iShares or rival Vanguard.

The absence of the No. 1 and No. 3 sponsors from Schwab's line-up results from these firms having created their own free-trading arrangements. You can't get the most widely used funds from No. 2 ETF sponsor
State Street
(STT), either. Schwab customers instead will have to use an equal-weight Guggenheim ETF if they want a commission-free U.S. sector fund. In ETFs as in any investment, there's no such thing as a free lunch.

AFTER A RELATIVELY QUIET start to the year, new ETF launches picked up the pace in mid-February. The area of focus says something about the investing climate. There are new income-themed funds that could tempt the yield-starved to take on riskier investments, and a pair that should appeal to investors who worry about the value of a dollar.